American Eagle Doesn't Suck

Solid and still not overpriced. Eh, there are crummier stocks to hold.

That's how my colleague Nate Parmelee reacted to the earnings release from American Eagle Outfitters(NASDAQ:AEOS) that hit the wires this morning.

He was kidding, of course. American Eagle may be many things, but right now, a sucky business it is certainly not. And the numbers make this perfectly clear.

For Q2, American Eagle put up 16.8% top-line growth, and leveraged that into 24.3% growth in net income. The $0.47 per share looked like even better growth, thanks to fewer diluted shares. It also pulled the old beat-by-a-penny trick, but I wouldn't get so excited about that.

Here's what I would get excited about. Specifically, take a look at those margins. They continue to get better, which is exactly what you want to see from your retailers. Part of that is, of course, accounted for by same-store sales growth of 10%.

But take a look at that inventory management. Sales are up, but inventories were actually trimmed slightly from the prior-year period. That's in stark contrast to a sales/inventory screamer like Pacific Sunwear(NASDAQ:PSUN) these days.

Management credits tight inventory control made possible by the company's ability to control flow of product where and when it's needed. (Shipping investors may wish to note that American Eagle has been able to successfully offset some of its air freight fuel surcharges by negotiating reduced rates on boats. Hmmm.)

There's more worthy of note for investors, but the list of goods is too long for a short take. Suffice it to say that American Eagle is running its business well enough so that moderate sales growth flows reliably to the bottom line and turns into cash -- although free cash flow this year will be a bit stunted by capital expenditures.

Of course, some of that capex is going toward the much-anticipated (by me, anyway) Martin + Osa chain, American Eagle's clothing concept for 25- to 40-somethings. The company now hopes to have at least 20 of these stores open by the end of 2007, and with the usual suspects like Gap(NASDAQ:GPS) and Abercrombie & Fitch's (NYSE:ANF) Reuhl failing to resonate with this demographic -- it's just a weirder, louder, darker, Disneyland caricature of Abercrombie, really -- I think Martin + Osa has some great opportunities ahead.

Whether or not that new concept is a hit will probably determine, in retrospect, whether or not American Eagle's stock is a buy at current prices. My super-happy valuation spreadsheet spits out a number that suggests that American Eagle is fairly valued these days on the future prospects of the current operations alone. Personally, I look for a more obvious discount before I plunk down my bucks.

Investors interested in paying up for what looks like a premium company might be pleasantly surprised by Martin + Osa. But with all the carnage in the space -- just look at PacSun, Chico's FAS(NYSE:CHS), and Urban Outfitters(NASDAQ:URBN) -- I think experienced retail buyers might be better off sifting through the wreckage and looking for deeper bargains. After all, buying the pessimism is how many of us made such good money on American Eagle over the past year.

Seth Jayson hopes Martin + Osa's duds will make his abs look washboardy. At the time of publication, he had shares of American Eagle, but no positions in any other company mentioned. View his stock holdings and Fool profile here. Fool rules are here.